EUR 850.00 For Business Accounts Only

Morningstar | Estee Lauder Finishes Fiscal 2018 on Strong Footing; Shares Trading in Line With Valuation

Wide-moat Estee Lauder finished its fiscal year on a stellar note, with net sales up nearly 16% (a touch above our 15% expectation) and adjusted operating margin expanding 70 basis points to 16.6% (comparable to our estimate). In our view, these results reflect the substantial brand equity inherent to Estee Lauder's portfolio of prestige beauty brands. As evidence, constant currency sales of the firm's namesake brand grew 22% and La Mer became its fourth brand to generate more than $1 billion in sales. Further, premiumization trends and higher beauty spending continued to lift fourth-quarter sales in the Asia-Pacific region (roughly one fifth of sales), as constant currency revenue grew 24%, on top of an 18% increase in the prior-year period. While we may adjust our near-term outlook to incorporate these results, we aren't expecting a significant change to our $139 fair value estimate, which calls for above 6% revenue growth and 17% adjusted operating margin on average over the next five years. We continue to view shares as fairly valued.

From a category perspective, the skin care segment (42% of sales) continued to fuel top-line growth in the fourth quarter, with constant currency sales up 26% on further strength in China and the Europe, Middle East, and Africa segment as well as the travel retail channel. Moreover, segment operating margin expanded 380 basis points to 21%, thanks to an increased contribution from the Estee Lauder and La Mer brands. We expect the skin care segment will continue to outpace growth in segments like fragrance and hair care, which should also yield positive mix effects. We attribute the higher operating margin in this business to material pricing power, as we contend skin care consumers are averse to untested products, lead to strong brand recognition and price inelasticity.

We continue to see opportunity in the firm's online business (above 10% of sales), as it continues its endeavors to diversify the channels through which its products are sold. We estimate roughly one third of the firm's sales are through faster-growing channels like travel retail, specialty multi-brand stores, and brand sites. From our perspective, a shift toward these channels and away from North American department stores (18% of fiscal 2017 sales), where traffic remains sluggish, is prudent. We contend that the firm will continue to support its expansion in these channels through investments in advertising and promotion, which have averaged around $2.6 billion, or 24% of sales, annually over the past five years. In this context, management noted that around two thirds of its advertising spending is now for digital, versus 50% the year prior, indicating strengthened support for this channel.